Ten Myths of Government Contracting: Myth No. 5: My prime contractor will tell me what clauses should be in our subcontract

I have lost count of the number of times I have heard this one. Anyone who believes it is true needs some immediate counseling, because this is a recipe for disaster. Let’s start by stating the obvious: a prime contractor has its interests to protect and a subcontractor must protect its own interests. The interests of the two parties are going to overlap a great deal, but they are never going to be identical.

As I mentioned in Myth No. 4, there are a lot of landmines in a Government contract and any subcontract issued under it, and a subcontractor has to take the time to ensure that the agreement it signs does not pose any unacceptable risk. You can’t do that without reading and understanding the document. You will rarely be able to eliminate all risks up front, but you have to try to identify and minimize them.

I am not suggesting that prime contractors are dishonest. The fact is that many companies serve as primes on some contracts and subs on others, and they are well aware that their strategy will be affected by their role. Having been on both sides of the table might actually be helpful to them in negotiating a deal.

Large primes are famous for sending a set of terms and conditions to potential subs with a note indicating that these are the prime’s “standard terms and conditions,” and requesting the sub to sign the document and return it promptly. Incredibly, many subs do just that because they are so desperate for the business. But the fact that this document might contain the prime’s standard terms does not mean that they are identical to a sub’s standard terms, and a sub would be foolish to simply accept them. Instead, the sub needs to review them carefully to ensure that it can live with what the prime has proposed.

For example, primes frequently utilize a “Pay When Paid” clause, meaning that the sub will not be paid by the prime until the prime has been paid by the Government. A sub has to determine when exactly that might be — in some cases it could be over 90 days after work has begun. Can you make it that long? The real problem in such situations is that the party with superior bargaining power will prevail, and subs therefore need to understand how much risk and pain they can absorb — that is a business decision. Lawyers can sympathize, but lawyers cannot resolve this for the parties.

In taking tough positions like this, primes are not acting unethically or immorally. They are simply capitalizing on their leverage and the sub’s hunger to get the deal done, and history shows that this is a very successful strategy. One could react to this point by concluding that it really is not worth it to challenge what the prime has handed down because it will be a losing effort, but that is not the case. While some of the provisions will certainly come down to economic leverage, others will not.

For example, the “Termination for Convenience” clause is unique to Federal contracts and enjoys such elevated status that courts have held that it will be “read into” a Federal prime contract even if the Government agency neglected to include it. Most prime contractors will insert this clause into proposed subcontracts because they want an exit ramp if the Government should decide to terminate the prime contract for convenience — a wise strategy. In the commercial world, however, a convenience termination is nothing more than a breach of contract, and since the agreement between a prime and a sub is a commercial transaction, the sub should insist that the Termination for Convenience clause be limited to those situations where the Government has actually terminated the prime’s contract for the convenience of the Government. The clause should also state that in the case of a partial termination of the prime contract, the prime will only be able to terminate that portion of the subcontract affected by the termination. Without such protection, a subcontract could be terminated at any time, for almost any reason, depriving the sub of the certainty of contract that is a staple of commercial transactions.

President Ronald Reagan was known for saying, “Trust, but verify” — wisdom borrowed from an ancient Russian proverb. Mr. Reagan used this phrase in the context of explaining the rationale for extensive verification procedures that were to be used in our Government’s dealings with the Soviet Union, a high-stakes process.

While your subcontract negotiations with a large prime contractor might not be of the same importance as diplomatic negotiations, they are important to you and your company, and your failure to protect your interests could lead to some unwanted problems down the road. Experienced prime contractors will not be offended by your attempts to negotiate certain terms and conditions. In fact, they would be surprised if you didn’t — they do it every day with their own primes.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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